Rational Expectations and Survey Data

Citation

Abstract / Synopsis

How economic agents form their expectations of future economic events has been an
importance issue in macroeconomics for many years. Indeed, business firm's
expectations has played a central role in the business cycle theories of both Pigou
(1927) and Keynes (1936). Acknowledging that the behavioral assumption of the
rational expectation is important to modem economic theory and econometric
modeling, this study is undertaken for the purpose of investigating whether the
Malaysian Business Expectation Survey For Limited Companies, provides the basis
for prediction which, satisfy the rational expectations hypothesis (REH) and
property in the sense of Muth (1961).
The business survey-based expectations, drawn from Business Expectations Survey
of Limited Companies (BESLC), conducted biannually by the Malaysia' s
Department of Statistic, offer a unique opportunity to accumulate empirical evidence
on expectation formation and decision-making at micro level. Four criteria of
'rationality' is examined in the study namely, unbiasedness, serial correlation of
forecasts error, weak-form efficiency and orthogonality. Essentially, this study utilizes business survey data in a manner that is different from
prior study by testing the rationality of firm's expectations at different level of
aggregation. Accordingly, the sectoral subdivisions are as follows: the aggregated
respondents of the BESLC survey data are group into three divisions of significant
sectoral in Malaysia: that is, primary sector, industrials sector and service sector. At
an even higher disaggregated level, the manufacturing sub-sector under the
industrial sector, which can be further segmented into consumer goods industry,
capital goods industry, as well as light and heavy intermediate goods industry.
Evidently, the significance of the use of disaggregated data is noted in this study.
Apparently, REH are rejected comprehensively when directs test were performed on
the sectoral segmentation level. At a higher disaggregated level, as the direct tests
are applied to the data from most of the constituent industries of manufacturing
sectors, these test provide at least some amount of direct evidence in favor of the
hypothesis, which is often simply assume to be valid, that expectations are rational
as defined by Muth (1961). Hence, this implies that the prior investigations of the
rationality of survey expectational data have overlooked relevant data by
disregarding the potential of aggregation bias encompassed by the aggregated survey
data. Although the presence of the aggregation bias has not been formally tested, the
results of this study here suggest that this potential bias may be of importance.